Outsourcing Agreements with Positive Incentive Price Structures to Drive PerformanceBy James Blake on
Outsourcing often provides cost efficient ways to procure quality goods and services. Yet, a successful outsourcing agreement must do more than simply lock in a good price or a mere time advantage – it must also provide a company with assurances for product quality, punctuality, and mechanisms to ensure the outsourcing agreement will be fully performed. To achieve this goal, your outsourcing agreement must engage a vender with performance driving incentives to offer rewards for enhanced quality and productivity as well as disincentives that prevent delays, disruptions, and other problems with quality and productivity.
Flat Fee & Cost-Plus Contracts: Pros & Cons
Flat fee and cost-plus contracts are the most common price mechanisms in outsourcing agreements. Flat fee and cost-plus contract structures provide the advantage certainty for cost and compensation to both parties. However, they do not reward a vendor when volume significantly increases. In fact, where quality or productivity may increase much faster than cost, the vendor might receive a negligible reward for improved services, products, or volume. This is a disadvantage for the outsourcing company because the vender has little incentive to increase quality or productivity. Thus, the vender’s outsourced product, service, or productivity level may remain stagnant, instead of growing to push the outsourcer toward greater excellence.
Re-Engineering Flat Fee & Cost-Plus Contracts
Several modifications to flat fee and cost-plus contracts can greatly enhance vendor incentives, driving both vender performance and outsourcer rewards. Volume-based bonuses are one mechanism to inject productivity incentives into a fixed or cost-plus contract. This encourages the vendor to increase productivity, but it does not necessarily increase product quality. It might even negatively impact quality where overzealous or unethical vendors take shortcuts to increase productivity. Earn-out or milestone approaches can be used to circumvent some of these problems. Milestones and earn-outs can be much broader in scope than volume-bonus approaches. For example, earn-outs might include achieving certain score levels on customer feedback surveys, product inspections, etc. With a much more broad-based incentive metric system than volume bonuses, milestones and earn-outs can help achieve better productivity with less risk of sacrificing quality.
Above all, it’s important to engage a contract attorney who can identify other hidden risks and custom tailor contractual solutions that prevent problems from emerging. The Blake Law Firm counsels medium and small businesses in both domestic and international outsourcing matters. Contact our Austin business law firm today to ensure that your company is not subject to problems and risks that could arise in your outsourcing agreements.
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